Marking Time: The Problem of Excess Cash

At the end of Q2 2012, non-financial S&P 500 companies held close to $1.2 trillion in cash and equivalents on their balance sheets. Overall, corporate cash has been increasing quarterly for U.S. companies. By the end of Q2 2013, just fifty companies in the S&P North American Technology Sector were holding $646 billion in cash and equivalents. Fifty companies!

While excess cash presents a different challenge, the trend is problematic. That $1.2 trillion is not being put to work for anyone and creating very little shareholder value. When cash sits on the balance sheet, it isn’t being deployed into IT infrastructure or capital improvements or research and development (R&D); it isn’t hiring or acquiring. In short, cash on the balance sheets isn’t furthering innovation or growth. And that is the biggest uncalculated risk for many companies: the risk of failing to innovate and failing to lay the foundation for future growth.

The choices businesses make for their excess cash, including the choice to maintain large cash balances, may have significant impact on shareholder value well into the future, yet few companies have a framework for choosing between the alternatives.

As the business environment becomes more complex, this lack of a holistic perspective on the uses of cash is both more apparent and challenging. The unprecedented confluence of factors in the U.S. and global economies driving cash accumulation also complicates cash deployment decisions. Among these factors: a proliferation of cheap financing alternatives, increasingly globalized business models, disparate tax rules which discourage bringing overseas cash back to U.S. shareholders, limited “good” M&A deals, and constraints on companies’ abilities to generate returns from internal R&D activities. In addition, the memory of the 2008 crash and liquidity crisis continues to influence some cash considerations.

Another complicating factor is the rate of change, both in terms of technologies and global economic and public policies. Rapidly evolving technologies are increasingly prevalent in many aspects of the business, across sectors and regions. Companies need infrastructure investments not just to maintain productivity and continuity in a more mobile, more connected workforce, but in some cases just to remain viable and relevant. Small companies, focused on very specific uses of emergent technologies, may suddenly be competitors. They may also offer critical enablers for future growth, but as acquisition targets, are hard to evaluate.

The resulting uncertainty makes it more difficult for companies to evaluate alternative uses for excess cash within the existing frameworks. Holding cash on the balance sheet might seem a prudent option. While retained cash can improve resilience and flexibility in the face of another liquidity crisis, failing to invest for growth might actually pose the biggest risk for corporations.

Do Shareholders Care About Excess Cash?

For some companies -- those with a history of effectively deploying capital for organic and inorganic growth and innovation -- shareholders are content to watch the cash balances rise without penalizing the stock price. But for many other companies, especially those who have suffered internal missteps, declining sales volumes or missed financial targets, shareholders are antsy. The past twelve months have seen shareholder activists pushing for cash to be returned in the form of dividends -- such as accelerated, special, in-kind -- or share repurchases. While these techniques may satisfy impatient shareholders in the short-term, for growth sectors such as technology and life sciences, returning cash won’t be enough to meet the shareholder expectations reflected in the stock price. For maximizing shareholder returns, cash should be treated as an important ingredient for growth, while capital distribution is reserved for mature companies.

What Can Be Done?

There’s no single answer. Companies, however, need a broader approach to cash deployment within the context of the business. Now, many companies do not have a framework for identifying and evaluating the various alternatives for cash in a way that considers the company, present and future, holistically. Instead, decisions tend to be made ad hoc or in silos -- options for capital distribution might be weighed amongst themselves and options for capital investment evaluated against ROI hurdles but not as a whole. Global tax implications may be required for some companies. For others, it is shareholder demands. Many businesses also lack good data with which to analyze the costs, benefits and expected returns, for alternatives such as R&D.

The question for management is not, what are the alternatives, but what are the alternatives or combinations that make sense to a particular business?

Ideally, an entity would analyze its business cases for uses of cash, internal and external, through the same lens. First, for each alternative, consider the impact on the organization. Does the organization have the capacity and readiness to execute to these strategies? If you have recently completed several M&A transactions, do you have the capacity to effectively integrate another business or should you delay and consider other alternatives? Do you have the skills to manage additional capital improvements or R&D processes? Does the alternative fit within other strategies for growth or financial management? Is the timeline for additional R&D or for an infrastructure project feasible within other company priorities?

Second, how will shareholders and the market react to your alternatives? How much cash and leverage do your competitors have? Develop a communications strategy that articulates your capital deployment and distribution strategy and, more importantly, describes how you determined the selected alternative for the company. Forgetting to communicate the how and the why of capital deployment can be as detrimental, to the professional and the company, as failing to formulate an effective capital strategy in the first place.

This is an interesting and challenging time for businesses with the luxury of excess cash. The good news is that some of the broader economic conditions driving the accumulation of cash seem to be easing. In a recent survey of CFOs for U.S. companies, less than twenty-percent expected that hedging against business volatility would be a top use of cash. With sixty-percent planning to invest internally and fifty-percent looking at acquisition opportunities, companies overall seem to be returning to the idea of gearing up for growth. It seems hopeful that cash will once again be put back to work. The missing piece, now, is a framework focused on value creation over the long-term that focuses on maximizing the shareholder value of that cash.

Eric Openshaw is a vice chairman and the U.S. Technology, Media and Telecommunications leader for Deloitte LLP. Dan Knappenberger, CFA, ASA, who also contributed to this post, is principal and the Technology sector leader for Deloitte Financial Advisory Services LLP.